Week of 12/20/2021

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Market Signals Divide With Fed… Federal Reserve Accelerates Taper… Economy “Isn’t Strong” Gundlach… MTA Tests Fare Cap… Dirt Bonds Shine… Demand for Senior Housing… PREPA Plan of Adjustment in Spring 2022…

Market Signals Divide With Fed… Traders dismissed the Federal Reserve’s projections of how far the central bank would be able to lift interest rates. Trading in futures markets suggests that the central bank may not raise rates beyond 1.5% in the years ahead and could have trouble raising rates beyond 2023. The divide between the markets and the Fed underscores uncertainty about future economic growth and central bank efforts to tame higher inflation. Rate hikes could clamp down on inflation, but concerns about economic growth during a prolonged pandemic put a cap on how high the Fed can raise rates. The Fed’s dot plot is also out of sync with the European Central Bank, which has ruled out the possibility of raising rates in 2022 despite higher inflation. The shape of the yield curve, or the yield gap between short term and longer dated paper has raised questions. More sensitive to federal funds rates, short term Treasury yields have increased while longer dated yields are weighed down by market’s low expectations of the level of rate hikes in this tightening cycle.

Federal Reserve Accelerates Taper… Federal Reserve officials agreed to accelerate winding down central bank bond purchases, on track to end the taper by March. The Federal Reserve set the stage for interest rate hikes next spring. The Fed’s dot plot of interest rate predictions shows three quarter-point hikes in 2022 followed by another three in 2023. Most Fed officials project core inflation to reach 4.4% at the end of this year before declining to 2.7% next year and 2.1% by the end of 2024. Fed officials believe GDP growth will slow to 4.0% next year, 2.2% in 2023 and 2.0% in 2024. The Fed stopped describing inflation as ‘transitory’ in its latest policy statement, partly due to confusion over what the word means and to reflect greater uncertainty over how long it could take inflation to slow. “Supply and demand imbalances related to the pandemic and the reopening of the economy have continued to contribute to elevated levels of inflation,” the FOMC said. Fed Chair Jerome Powell stated, “The actual rate decisions we make will depend on our evolving assessment of the forecast. So, for example, if the economy were to slow down significantly, then you would expect that would have an effect of slowing down rate increases.”

Economy “Isn’t Strong” Gundlach… Bond maven Jeffrey Gundlach believes that the U.S. economy has been mischaracterized as ‘strong’ by the Federal Reserve given that unemployment exceeds 4%. “The economy is ‘pumped up on stimulus’ exactly because it “isn’t strong,” Gundlach declared. Despite the Fed’s efforts to control bond prices, market conditions support Gundlach’s view. Classic recession indicators like a yield curve inversion have not yet occurred but Gundlach observed the yield curve is flattening. The bond market is signaling its conviction that business activity is weaker than the Fed proclaims. “The yield curve is trending in a way that doesn’t suggest stronger growth in 2022,” Gundlach noted. Every time the yield curve has started to flatten over the last decade, some pundits have argued “this time is different.” Every time the pundits are “wrong.”

MTA Tests Fare Cap… To boost ridership, New York’s MTA will delay a planned fare hike and cap fares for at least four months on its subways and buses and lower commuter rail fees. On weekdays, subway ridership is about 57% and commuter rails carry about half the riders relative to 2019 levels. MTA expects ridership to reach to 86% of pre-COVID levels by 2024, a loss in farebox revenue. Capping fares could cost as much as $20 million and lower commuter rail fees come at a tab of $12 million over four months. Improving ridership will help the MTA address its long term budget shortfalls as federal aid to cover lost farebox revenue will dry up in 2025.

Dirt Bonds Shine… In Texas, Municipal Utility Districts (MUDs) build drainage infrastructure to mitigate severe weather impacts. Texas area has weathered frequent storms without suffering widespread declines in market values or downgrades. Solid population influx has fueled real estate market value growth, creating bondholder security. State oversight on debt practices includes Texas Constitution requirement that voters approve all tax revenue secured debt. Higher rated MUDs boast low debt in relation to market value. Three-quarters of rated Texas MUDs are “A”/“BBB+” credits and carry mostly stable ratings with upgrades outpacing downgrades. Housing infrastructure related tax-exempt bonds that are secured by property taxes are often found in fast growing states such as CA, CO, TX, FL.

Demand for Senior Housing… Occupancy at independent and assisted living facilities remained relatively stable post-COVID-19 while skilled nursing demand softened. Slowdown in surgical procedures during the pandemic weighed on skilled nursing occupancy. The impact of technology on care delivery, aging in place trends and the relative safety and community offered by the quarantined setting of senior housing facilities shape occupancy trends for the senior housing sector. The pandemic brought operating losses for senior housing providers and a wider performance gap across various credit ratings. Hard-hit by the pandemic, long term care entities received $53 million in COVID-19 related federal aid.

PREPA Plan of Adjustment in Spring 2022… “These discussions have been productive, but have difficult obstacles to overcome,” the Oversight Board has held discussions with PREPA bondholders that are party to the May 2019 Restructuring Support Agreement known as the ‘RSA’ regarding implementation of the debt plan. The RSA envisions exchange of legacy debt into new electric utility bonds. “The securitization bonds to be issued pursuant to the PREPA RSA require certain legislation, including legislation to establish the securitization structure of the proposed new bonds and the transition charge needed to support prospective debt service,” the Federal Oversight Board added. “The Oversight Board intends to engage with Puerto Rico’s fiscal agency, the Governor and the Legislature in discussions to determine what legislation they are willing to pass to implement the RSA.” The Island’s Oversight Board looks to file a plan of adjustment for restructuring electric utility debt in the Title III court in March 2022.

Compare 30-Year taxable U.S. Treasury yield 1.81% to 30-Year tax-exempt muni bond yield “AAA” 1.54%; “AA” 1.70%; “A” 1.95%; “BBB” 2.59%. For investors in the 35% tax-bracket, a 2.4% tax-exempt yield is equivalent to a 3.85% taxable yield. Top rated tax-free bonds yield 85% of comparable taxable U.S. Treasuries.